All information and commentary herein has been prepared solely for informational purposes, and is not an offer to buy or sell, or a solicitation of an offer to buy and sell any security or instrument or to participate in any particular trading strategy. Any commentary contained is not to be construed as to the rendering or offer to render personalized investment advice. The information is limited to providing you with general information on our services and philosophy, and opinions. Such an offer can only be made in the states that Gary Clemmons or Texas Brokerage Asset Management (TBAM) is either registered or a notice filer or an exemption from registration is available under the securities laws or other laws or that state. TBAM expressly disclaims all liability in respect to actions taken based on any or all of the information that may be contained. Use of the information herein may not be appropriate in your particular circumstances. Securities offered through Rydex Financial Services, a division of Rydex Distributors, Inc., member NASD/SIPC. Rydex Financial Services, 9601 Blackwell Rd. Suite 500, Rockville, MD 20850 November Rally November and December are possibly setting up to be some decent months for trading from a historical perspective. So, we will want to participate if we can do so from a reasonable risk / reward perspective. November is the top S&P month (1.7%) and number three on the Dow (1.7%) since 1950. Since 1971 November ranks third for NASDAQ (1.9%) and fourth for both the Dow and S&P, averaging 1.4% each. Since 1989 November ranks second on the Dow with a 2.3% average gain and third for both the S&P (1.9%) and NASDAQ (2.5%). November begins the Best Six Months for the Dow and S&P, and the Best Eight Months for NASDAQ. On the Monday before options expiration day, the Dow was down 7 of the last 12. But on options expiration day the Dow rose 7 of last 12. The week before Thanksgiving Week, the S&P has been up 11 years in a row. As for trading the Thanksgiving Market, going long into weakness Tuesday or Wednesday before Thanksgiving and staying through the following Monday has improved returns in recent years. The days before and after Thanksgiving Day, combined, have had only 9 losses in 51 years on the Dow.
Cautionary Warning Now, no matter how bullish of a case we want to put on the seasonal strength of the market, especially going into the end of year run, it's hardly earth shattering news to be told that stocks are, if not overvalued, at least fully valued. After all, since we are one of those silly money managers that believe valuations do ultimately matter, we watch the traditional valuation ratios such as dividend yield and price-to-book ratios, for example, as warning signs. Value Line Investment Survey, a newsletter that is in first place in the Hulbert Financial Digest's rankings for long-term risk-adjusted performance, agrees with our concern. According to their VLMAP, which stands for Value Line Median Appreciation Potential, which represents the median amount by which Value Line's analysts are projecting the 1,700 stocks they collectively follow will rise over the next three to five years, there is cause for concern. Any VLMAP reading of 50 percent or below is a sell signal and recently the VLMAP reading was reported by Value Line to have dropped to 45 percent, one of its lowest readings in several years. Why is a VLMAP level of 45 percent considered to be bearish? One reason: The benchmark that, according to Value Line, is most highly correlated with VLMAP is the Value Line Arithmetic
Index which turns out to be upwardly biased. As a result, the average stock need not rise by very much at all over the next four years for the Value Line Arithmetic Index to rise by 45 percent. Another reason to be concerned about a VLMAP reading of 45 percent is that the stock market in the past has often found it rough going when the VLMAP was as low as it is today. 45 Overvalued Undervalued It dropped to below 50 percent in the late 1990s, for example, and though its bearish forecast was a bit early, the bear market that began in 2000 eventually vindicated it. (Remember, being early on a call, doesn t mean the call was wrong.) Prior to the late 1990s, the previous occasion on which the VLMAP dropped below 50 percent was in the months prior to what turned out to be the 1987 Crash. Giving further credence to market-timing systems based on VLMAP is that its buy signals have often been well timed. At the stock market's low in October 2002, for example, VLMAP stood at 115 percent. With only three exceptions, that was its highest level since before the stock bull market that began in August 1982. To more systematically document VLMAP's potential Hulberts Financial Digerst calculated the stock market's four year returns following all weeks since January 1972 in which VLMAP was below 50 percent. The results were somewhat surprising showing that the markets performance was little more than half the average four-year return following weeks in which VLMAP was above 100 percent. WARNING: A low VLMAP reading doesn t mean the market is ready to crash. VLMAP is focusing on where the market will be in four years' time, therefore, it is not and would not necessarily be inconsistent with VLMAP for the stock market to rally significantly over the shorter term. If so, however, the model would become even more bearish than it is now. Value Line, looks at a number of factors in determining its risk management posture, and therefore does not rely exclusively or even predominantly on VLMAP.
Right now, Value Line is relatively upbeat, recommending that subscribers allocate 75 percent of their equity portfolios to stocks. Nevertheless, perhaps in part because of the low VLMAP level, Value Line also writes: We also now caution that at these high price levels, the market could be at risk if earnings disappoint. Bullish Sentiment Early, Wrong or Broken? Pride comes before disaster, and arrogance before a fall. Investors continue to push the markets to higher and higher valuations under the guise of many different reasons which all basically revolve around This time it s different This is basically confirmed by the recent sentiment indicators which underscore this extraordinary level of bullish sentiment. Investors tend, and have always done so, moved in a herding fashion in the markets in one direction or another. It is a psychological trait that is part of our natural behavior. According to the latest research, the herd sentiment poll stood at 59.5. Any time the sentiment poll topped the 55 level stocks have become unraveled, typically falling 7 percent over the following 12 months.
As you can see the last several times the index rose above 55 the market has suffered declines at some point in the near future. This is not the first time that the indicator has appeared to be wrong most likely the indicator is just early. But it's not only the herd that's become extremely optimistic. Sentiment data for Wall Street strategists is hitting highs as well. Wall Street experts haven't been the best indicators of big bullish trends. The first time this group crossed the line of optimism into the extreme category, as measured by NDR, was back in 2000. The inverse is also true. When the index falls below 30, it reflects extreme bearishness. In March, when the crowd indicator was in the low 20 s it provided a good buy signal for the markets. Cash Is Not Trash As one of my favorite hedge fund managers writes; In the meantime, while it's no fun holding cash that pays scant interest, you should take some solace in that you've got pretty good company. As an Oct. 27 Barron's interview with Warren Buffett recounted, it's what one of the world's greatest investors is doing. He s sitting on $24 billion. Cash is not trash. People work so hard to earn it. But once they have it in their portfolios, they act as if it's going to give them a communicable disease. It s not a disease to be gotten rid of as soon as possible. It does need to be cared for... Remember, sometimes conserving your principal to avoid major market draw downs requires doing things that may not be popular or fun. It s kind of like taking medicine It tastes real bad going down, but you will feel a lot better later. The Solution We constantly talk about risk management which is nothing more than odds and statistics. In other words, by using history as a guidepost, and by doing some homework we can at least try to put the odds of what may happen in the future into our favor, thereby, reducing the overall risk to our principal investment. By learning to manage for the short term risks we can all become better long term investors. Again, I hope you find my efforts worth your time I recognize that making predictions, especially out-of-consensus ones is usually a precursor to egg on your face. That being said, if I start thinking like the herd, what value to you would I be? I hope I made you think, even if I ultimately prove to be wrong.